Milton Friedman 1912-2006: A Short Appreciation

The core of Milton Friedman’s economic philosophy, from which all else flowed, was the proposition that “inflation is always and everywhere a monetary phenomenon.” Tell me how fast the government is allowed to increase the supply of money, and I’ll tell you how much inflation it will inflict on the free enterprise economy-which, by the way, has always existed in the United States. “The most important fact about enterprise monopoly is its relative unimportance from the point of view of the economy as a whole,” Friedman wrote in 1962. “There are some four million separate operating enterprises in the United States; some four hundred thousand new ones are born each year, a smaller number die each year . . . . In almost any in industry that one can mention, there are giants and pygmies side by side.” Keep the government out of the economy and finance in every way, starting with its monopoly over the nation’s money, and our competitive free enterprise system will flourish.

Friedman’s definitive triumph, most of the articles on his life report, took place in the 1970s, when he supposedly disproved the economic policies of John Maynard Keynes. “Even as he was being dismissed as an economic ‘flat-earther,'” writes Holcomb Noble in The New York Times (November 17), “he predicted in the 1960s that the end of the boom was at hand. Expect unemployment to grow, he said, and inflation to rise, at the same time. The prediction was borne out in the 1970s. It was Paul Samuelson who labeled the phenomenon stagflation. Mr. Friedman’s analysis and prediction were regarded as a stunning intellectual accomplishment and contributed to his earning the Nobel for his monetary theories.” Greg Ip and Mark Whitehouse (Wall Street Journal, November 17) add that “Along with economist Edmund Phelps, this year’s Nobel Prize winner, Mr. Friedman in the 1960s also developed the theory that policy makers couldn’t maintain low unemployment by permitting higher inflation. The view holds sway at major central banks today, including the Fed, and helped to defeat the inflation of the 1970s and set the stage for the low inflation and low unemployment of the 1990s and today. It took Paul Volcker, who became Fed chairman in 1979, to put the monetarist theory into practice, adopting money-supply targets that drove interest rates to double digit levels, sent the economy into a deep recession, and ultimately brought inflation down drastically.”

Here is Friedman’s pronouncement in 1974 on the skyrocketing oil prices brought on by OPEC oil production cutbacks that began in October 1973: “The world crisis is now past its peak. The initial quadrupling of the price of crude oil after the Arabs cut output was a temporary response that has been working its own cure. Higher prices induced consumers to economize and other producers to step up output . . . In order to keep prices up, the Arabs would have to curtail their output to zero; they would not for long keep the world price of crude at $10 a barrel. Well before that point the cartel would collapse” (Newsweek, March 4, 1974).

In other words, money is “neutral”: since increases in the price of oil, or any other price, do not produce a rise in the stock of money, they will not produce inflation. Thus, while the OPEC cartel was raising its prices, the world would not suffer, because all other goods would continue to be produced-and sold at lower prices. The average price of goods in general would change very little; inflation would be insignificant; and no real production or employment losses would take place.

Oil prices were running at $3 to $4 per barrel before the fall of 1973; they shot up to $14 per barrel by 1978 and $35 in 1981-an eight year long “crisis” by most standards. Starting in 1979, the U.S. Federal Reserve under Volcker did try to roll back inflation, not by setting money-supply targets (which in any event is exceedingly hard to achieve) but by raising interest rates to record high levels. The result was severe recession, stretching from the first half of 1980 through 1982-the most prolonged economic slump since the 1930s. As the economy contracted, unemployment mounted, solely because the Federal Reserve was putting a tight squeeze on the economy-not, as Friedman was predicting in the 1960s and 1970s, because the government was creating and spending too much money in the mistaken Keynesian belief that it could stimulate the economy and bring down the unemployment rate. “Expect unemployment to grow, [Friedman] said, and inflation to rise, at the same time” (the Times’s Noble points out).

In fact, as the official unemployment rate rose from 5.8 percent in 1979 to a record postwar level of 10.8 percent in late 1982, the money supply was shrinking dramatically, growing 13.3 percent in 1979 and only 3.8 percent by 1982. It might also be asked why a Friedmanite Federal Reserve would have allowed any growth in the money supply at all so long as price levels were on the rise.

And this is what the money supply and inflation, which are supposed to track each other closely, looked like during the time of Friedman’s triumph:

Since 1990, most economists and financial authorities believe that the money supply should be measured as “M2,” which includes not only currency (cash) in the hands of the public and checking accounts in banks (“M1,” as shown above), but also money market accounts and savings deposits. By that measure 1993 through 1994 would look substantially different (the three other periods would not): M2 money supply increased 84 percent, prices 31 percent.

For the legacy of Milton Friedman, rarely in history have so many heaped so much credit on so little. No need (more likely, no stomach) for going into the rest of Friedman’s totally antistatist edifice-his opposition to all forms of government regulation and spending (except military), his opposition to public education and Social Security . . . and his role as economic adviser to the Pinochet regime in Chile that engineered a coup in 1973 against the democratically elected president, Salvador Allende. But the latter, for Mr. Friedman “was just a bump in the road,” the Times’s Noble assures us, although one wonders whose road that might have been.